Verizon Communications's (VZ -2.99%) third-quarter 2023 earnings report impressed investors. The stock rose 9% in the following trading session amid the company's rising free cash flow, which suggests that its high dividend is safe.
However, a deeper look at its finances may not bode well for the dividend. And given its business conditions and the performance of a key competitor, eliminating the payout could be a better decision for Verizon. Here's why.
Verizon stock and its dividend
Some of Verizon's financial challenges persist. Revenue for the first nine months of 2023 came in at $99 billion, a drop of 3% compared with the same period in 2022. Likewise, net income of $15 billion fell 3% year over year.
However, thanks mostly to falling capital expenditures (capex), or spending on its network, free cash flow for the first three quarters of 2023 was just under $15 billion, up from just over $12 billion in the same quarter last year.
That arguably has changed the fortunes of the dividend. A rising payout combined with a secular decline in the stock price has left Verizon with a 7.7% dividend yield. This is more than AT&T at just above 7% and nearly five times more than the S&P 500's 1.6% average yield. The fact that the dividend cost the company just over $8 billion in the first three quarters of the year makes the payout appear safe.
Still, the yield has risen due to Verizon's poor share performance during the past few decades. The stock is down 23% over the previous five years in terms of total return and sells for levels comparable to late 1990s. Consequently, its price-to-earnings (P/E) ratio is under 7.
Data source: YCharts
Why the dividend may still not be safe
Still, the valuation and dividend yield may mean Verizon stock is cheap for a reason. Amid high capex and spectrum costs, total debt stands at $147 billion. Although that fell $3 billion during the past nine months, it is still much more than the $99 billion in stockholders' equity.
Also, nearly $13 billion of the debt matures during the next year, and since $8 billion of its free cash flow goes to the dividend, Verizon may have to refinance some of that debt at higher interest rates.
But even with somewhat lower capex spending, it remains an ongoing concern. Verizon allocated just over $14 billion on its network in the first three quarters of 2023. It has had to spend heavily to keep up with AT&T and T-Mobile.
Moreover, Verizon cannot afford to cut capex spending significantly as it gears up to build a 6G network over the coming years. Additionally, Verizon potentially faces billions in cleanup costs over toxic lead cables it installed decades ago, another factor that could hurt its free cash flows.
Such costs call into question whether Verizon can afford its payout over the long term. For example, T-Mobile's stock dramatically outperformed Verizon's and AT&T's over the last few years -- and it didn't pay a dividend during that time.
T-Mobile announced in September that it would begin paying a dividend. Nonetheless, its performance in recent years suggests such stocks could benefit by eliminating their payouts.
Do not buy Verizon stock for the dividend
Admittedly, a low P/E ratio and rising free cash flows indicate Verizon's stock may be close to a bottom. However, what might likely make the telecom stock a better investment is eliminating its dividend.
The need for heavy capex spending is the primary reason for Verizon's $147 billion in debt. Given the $13 billion coming due soon and a likely need to refinance at higher rates, debt reduction would likely be a better use of the $8 billion Verizon spent on dividends over the past nine months.
Additionally, T-Mobile's strong performance without a dividend indicates the dividend is not worth the cost to shareholders. Thus, if Verizon eliminates its payout (or at least reduces it significantly), it could become a buy.
Will Healy has no position in any of the stocks mentioned. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.
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October 27, 2023 at 07:50PM
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